Deepening Insolvency in Canada?

Deepening Insolvency in Canada?

Jassmine Girgis*

its

The Canadian legal landscape on corporate
directors liability has been quiet since the release of the
Supreme Court of Canadas landmark decision in
Peoples Department Stores Inc. (Trustee of) v. Wise. In
Peoples, the Court decided against imposing a duty on
directors to consider the interests of creditors when
carrying out their fiduciary duties to a corporation
approaching insolvency. It appears, however, that an
American doctrine that holds directors and related third
parties liable for deepening the insolvency of the
corporation when
life has been wrongfully
prolonged, and one that is on the radar in Canada, has
the potential to affect the way Canadian courts view
director liability. Peoples may have closed the door to
imposing director duties to creditors but the American
doctrine of deepening insolvency, if adopted in
Canada, has the potential to do an end run around
Peoples by indirectly providing protection for creditors
when the corporation is facing insolvency.

The author discusses the implications of adopting
the deepening insolvency doctrine in Canada and
concludes that the doctrine is not necessary, as
Canadian business law already has several functionally
equivalent or similar remedies to address the harms
deepening
to overcome. Most
importantly, the oppression remedy, a doctrine deemed
by the Supreme Court of Canada to deal with situations
of near insolvency, could be expanded to address the
concerns of creditors. Other potential avenues include
claims for breach of fiduciary duties and duties of care,
as well as claims for negligent or fraudulent
misrepresentation.

insolvency seeks

les

la

peroivent

responsibilit

la faon dont

lapprofondissement de

Le paysage juridique relatif la responsabilit des
administrateurs de socits est devenu tranquille depuis
la dcision de la Cour suprme du Canada dans laffaire
Magasins rayons Peoples inc. (Syndic de) c. Wise.
Dans Peoples, la Cour a decid de ne pas imposer aux
administrateurs une obligation fiduciaire envers les
cranciers dune socit quand une socit approche
linsolvabilit. Par contre, une doctrine amricaine qui
dclare la responsabilit des administrateurs et des tiers
pour
linsolvabilit dune
socit lorsque sa vie est injustement prolonge, et qui a
suscit un certain intrt au Canada, semble avoir le
potentiel daffecter
tribunaux
canadiens
des
administrateurs. Peoples a peut-tre ferm la porte la
responsabilit des administrateurs envers les cranciers,
mais cette doctrine amricaine a le potentiel de
surmonter lobstacle pos par Peoples en offrant une
protection indirecte aux cranciers lorsquune socit
est proche de linsolvabilit.

Lauteure analyse les implications dune adoption
potentielle de la doctrine amricaine au Canada et
conclut que la doctrine nest pas ncessaire. Le droit
canadien des affaires contient dj plusieures voies de
droit qui
fonctionnellement
quivalentes du point de vue des torts que la doctrine
vise rectifier. La plus importante est le recours en cas
dabus, une doctrine que la Cour suprme du Canada
considre
situations
dinsolvabilit et qui peut tre tendu afin dadresser les
soucis des creanciers. Dautres avenues potentielles
incluent des demandes fondes sur un manquement
lobligation de fiducie et de diligence, ainsi que des
demandes allguant des reprsentations errones,
ngligentes ou frauduleuses.

sont

similaires ou

comme

applicable

des

* Assistant Professor, Faculty of Law, University of Calgary. This article was written for the
Canadian Insolvency Foundation and was funded by a Second Annual Lloyd Houlden Research
Fellowship. I am grateful to Thomas G. Telfer for numerous discussions, Anthony Duggan, Randal N.
M. Graham, Christopher C. Nicholls, Stephen Pitel, Thomas G. Telfer and Bruce Welling for their
comments on an earlier draft, and to my research assistant, Philip Grassie. I would also like to thank
the Faculty of Law, University of Western Ontario, for providing research assistance for this project.
The views expressed in this article are entirely mine and should not be taken as representing those of
the Canadian Insolvency Foundation.

Jassmine Girgis 2008
To be cited as: (2008) 53 McGill L.J. 167
Mode de rfrence : (2008) 53 R.D. McGill 167

[Vol. 53

169

173

175
175
179

181

184

184
184

184
185
187
189
190

190

193

197

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

168

Introduction

I. Duties to Creditors of Corporate Directors in Canada

II. The Doctrine of Deepening Insolvency in the United States

A. What is Deepening Insolvency?
B. Recognition of Deepening Insolvency

III. Deepening Insolvency and the Business Judgment Rule

IV. Analysis: Canadas Adoption of Deepening Insolvency?
A. Oppression Remedy: A Functionally Equivalent Canadian

Doctrine
1. What is the Oppression Remedy?
2. Differences between the Oppression Remedy
and Deepening Insolvency and Whether They
Matter
a.
b.
c. Quantifying Damages

Identity of the Plaintiffs
Identity of the Defendants

3. Conclusion on Oppression Remedy

B. Claim for Breach of Duty: Another Functionally

Equivalent Canadian Doctrine

C. Claim for Negligent or Fraudulent Misrepresentation:

Similar but not Identical

Conclusion

2008]

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

169

Introduction

The Canadian legal landscape regarding the liability of corporate directors has
been quiet since the release of the Supreme Court of Canadas landmark 2004
decision in Peoples Department Stores Inc. (Trustee of) v. Wise.1 Prior to Peoples, the
Canadian position had slowly been moving toward the recognition that directors
fiduciary duties take into account the interests of creditors as a corporation
approaches insolvency, a position similar to the statutory duty imposed in the United
Kingdom under its [w]rongful trading provisions.2 This move was sharply halted
when the Court in Peoples decided against imposing such duties and determined that
although directors duties of care could encompass various constituents, their
fiduciary duties are owed only to the corporation3 and do not change to encompass
creditors as the corporation approaches insolvency.
It appears, however, that Peoples may not be the last word on the subject of

Canadian directors liabilities in cases of looming insolvency. An American doctrine
that holds directors and related third parties liable for deepening the insolvency of
the corporation has the potential to affect the way Canadian courts view director
liability. Peoples may have closed the door to imposing on directors duties to
creditors, but the American doctrine of deepening insolvency, if adopted in Canada,
has the potential to do an end run around Peoples by indirectly providing protection
for creditors when the corporation is facing insolvency. This paper will discuss the
implications of adopting the deepening insolvency doctrine and conclude that the
doctrine is not necessary, as Canada already has remedies to address the harms
deepening insolvency seeks to overcome.
The duty rejected in Peoples called for the consideration of creditors interests

when a corporation is in the vicinity of insolvency.4 The duty imposed by the
deepening insolvency doctrine is different. Deepening insolvency holds directors
liable for harms suffered by the corporation when its life is wrongfully prolonged.
The doctrine imposes on directors a duty to the corporation, but it also indirectly
benefits creditors: first, by bringing money into the debtors estate to repay creditors
if the claim against the directors is successful, and second, by restraining the actions
of directors when the corporation is suffering financially, through the threat of
liability.

1 2004 SCC 68, [2004] 3 S.C.R. 461, 244 D.L.R. (4th) 564 [Peoples].
2 Insolvency Act 1986 (U.K.), 1986, c. 45, s. 214.
3 There are some statutory exceptions. For example, directors have duties to employees and can be
held personally liable for unpaid wages (Canada Business Corporations Act, R.S.C. 1985, c. C-44, s.
119 [CBCA]).

4 Supra note 1 at para. 46.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

170

The doctrine of deepening insolvency originated in the United States in 19805

and has gained ground most significantly in the last seven years. Since the seminal
decision Official Committee of Unsecured Creditors v. R.F. Lafferty & Co.6
determined that deepening insolvency constituted a valid cause of action under
Pennsylvania law,7 numerous claims for deepening insolvency have been made
throughout the United States. The reactions of U.S. courts to these claims, however,
have fallen along a spectrum and have ranged anywhere from recognition of the
doctrine as an independent tort, to its recognition as a theory of damages, to a
rejection of the doctrine altogether. The doctrines development has been a cautious
and uneven one, but over the last twenty years its contours have been coming into
focus and it has become, albeit somewhat grudgingly, a commonly recognized phrase
in American jurisprudence.
Although jurisprudence on deepening insolvency has been gaining momentum,
the doctrines validity was recently dealt a significant blow in the United States. The
Supreme Court of Delaware, through its affirmation of the Delaware Chancery
Courts far-reaching decision in Trenwick American Litigation Trust v. Ernst & Young,
LLP,8 refused to recognize deepening insolvency as a cause of action, leading some
commentators to question whether the decisions have effectively brought an end to
the deepening insolvency doctrine.9 While making a determination of this nature is
still premature, the future of the deepening insolvency doctrine has been brought into
question. That is not to say, however, that all proponents of the doctrine have fallen
sway to the recent criticisms. Indeed, some commentators continue to believe that the
doctrine remains a viable theory that can, and should, be salvaged. One commentator
bases such a view on the well-known adage bad facts make bad law to explain the

5 The concept of deepening insolvency originated in Re Investors Funding Corp. (523 F.Supp. 533
(S.D.N.Y. 1980)), in which it was stated that [a] corporation is not a biological entity for which it can
be presumed that any act which extends its existence is beneficial to it (ibid. at 541), but Schacht v.
Brown (711 F. 2d 1343 (7th Cir. 1983) [Schacht]) was the first case to coin the phrase deepening
insolvency. In Schacht, the United States Court of Appeals for the Seventh Circuit determined:
[The premise] that the fraudulent prolongation of the corporations life beyond
insolvency is automatically to be considered a benefit to the corporations interests …
collides with common sense, for the corporate body is ineluctably damaged by the
deepening of its insolvency, through increased exposure to creditor liability (ibid. at
1350).

See also Lawrence A. Larose, Samuel S. Kohn & Alexandra B. Feldman, Deepening InsolvencyIs
the Newest Tort Dead? (2006) 3 International Corporate Rescue 352 at 354-55.

6 267 F.3d 340 (3d Cir. 2001) [Lafferty].
7 Ibid. at 350.
8 906 A.2d 168 at 174 (Del. Ch. 2006), affd 2007 Del. LEXIS 357 (Del. Sup. Ct. 2007) [Trenwick].
9 See e.g. Hugh M. McDonald, Todd S. Fishman & Laura Martin, Laffertys Orphan: The
Abandonment of Deepening Insolvency (2008) 26 Am. Bankr. Inst. J. 1; Jo Ann J. Brighton, The
Trenwick Decisionthe Death Knell for Deepening Insolvency? (2006) 25 Am. Bankr. Inst. J. 32.

171

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

decision reached in Trenwick.10 Courts have also continued to recognize deepening
insolvency, both as a viable doctrine and as a theory of damages. Subsequent to the
Trenwick decision of the Delaware Chancery Court, the United States District Court
for the Southern District of New York recognized that a claim for deepening
insolvency would lie where the defendant either breached a duty owed to the
company or committed an actionable tort that contributed to the continued operation
of [the] corporation and its increased debt.11 With regard to use of the doctrine as a
viable theory of damages, the United States Bankruptcy Court for the District of
Columbia maintained that the deepening of a companys insolvency can be
harmful, and refused to disallow deepening insolvency as a viable theory of
damages unless told otherwise by a higher court in its own circuit.12

The lack of consistent treatment indicates that much has yet to be settled before
the fate of the deepening insolvency doctrine in the United States is determined.
However, regardless of the current unrest in the United States, questions about the
doctrines application in Canada have made their way across the border, as Canadian
lawyers continue to look at the doctrines functionality and applicability to Canadian
law. Reports on the doctrine have questioned its emergence north of the border,13
noting that the United States is often at the forefront before theories move north.14
With [e]xperience suggest[ing] that developments in the U.S. commercial laws tend
to be imported north of the border,15 restructuring bulletins have looked into whether
the U.S. theory will be adopted in Canada and have concluded that, instead of
recognizing the doctrine as a separate cause of action or a theory of damages,
deepening insolvency claims could be made under the oppression remedy.

10 Maaren A. Choksi, Sink or Swim? A Case for Salvaging Deepening Insolvency Theory (2007)
7 J. Bus. & Sec. L. 163 at 174-76. See also Taera K. Franklin, Deepening Insolvency: What it is and
Why it Should Prevail (2006) 2 N.Y.U.J. L. & Bus. 435 (maintaining that deepening insolvency can
provide a strong tool in enforcing corporate ethics by encouraging responsibility and adherence to
business ethics at 478); Kelly M. Hnatt, Deepening Insolvency: An Emerging Threat? (2008)
205:2 Journal of Accountancy 40 (claiming that the concept of deepening insolvency is gaining
prominence and continuing with advice on how to combat a deepening insolvency claim).

11 Devon Mobile Comm. Liquidating Trust v. Adelphia Communic. Corp. (In re Adelphia
Communic. Corp.), 2006 WL 687153 (Bankr. S.D.N.Y. 2006) (WL). See also Fehribach v. Ernst &
Young LLP, 493 F.3d 905 at 909 (7th Cir. 2007), Posner J. (concluding that the facts did not support
the claim of deepening insolvency).

12 Alberts v. Tuft (In re Greater Southeast Cmty. Hosp. Corp.), 353 B.R. 324 at 337-38 (D.D.C.
2006). See also Amato v. Southwest Fla. Heart Group, P.A. (In re Southwest Fla. Heart Group P.A.),
346 B.R. 899 (Bankr. M.D. Fla. 2006).

13 John R. Sandrelli & Sherryl A. Dubo, Receiverships and Insolvency: When Things Go Bad
(Paper presented to the Western Forum on Commercial Loan Finance & Security Conference, The
Canadian Institute, Calgary, 2829 May 2007) at 10 [unpublished], online: Fraser Milner Casgrain
.

14 Ibid.
15 W. Rostom, A. Kent & T. Weerasooriya, Deepening Insolvency: Will the U.S. Theory Be
Adopted in Canada? (June 2007), online: McMillan Binch Mendelsohn at 1.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

172

Furthermore, the doctrines potential adoption in Canada has been the subject of
debate at conferences in both Canada and the United States, one as recently as
January 2008.16 It is apparent that regardless of the direction in which the doctrine is
headed in the United States, deepening insolvency is on the radar in Canada. Contact
between Canadian and American lawyers has been increasing along with the number
of cross-border insolvencies. Such interaction, coupled with the availability of a
doctrine that has been developing for over twenty years and has the potential to
provide for the indirect protection of creditors and thus do an end run around Peoples,
indicates that it is a matter of time before an innovative lawyer attempts to make a
deepening insolvency claim in Canada. And when that happens, judges will need to
determine how claims for deepening insolvency will be handled.

To date there has been little or no academic analysis of whether Canada should
adopt deepening insolvency. Because the idea of importing the doctrine into Canada
may presently be enticing to some, the analysis in this article is thus necessary and
timely. I will consider whether Peoples rejection of a doctrine similar to that found in
the United Kingdom leaves a gap in Canadian law that could be filled with the
American doctrine of deepening insolvency, and whether that would be a desirable
outcome. My analysis will show that existing Canadian remedies are capable of
dealing with the harm deepening insolvency seeks to overcome, such that the
importation of the deepening insolvency doctrine is not necessary. Provided that
courts recognize a slightly enlarged applicability of the principle, the oppression
remedy may be a functional equivalent of deepening insolvency, as may a claim for
breach of duty. Claims for fraudulent or negligent misrepresentation may also provide
additional legal protection for certain creditors, though their similarities with
deepening insolvency are less pronounced.

Part I will briefly discuss directors duties in Canada. Part II will examine the
American position and explain the deepening insolvency doctrine, while Part III will
consider some policy implications of adopting the rule, specifically with regard to the
business judgment rule. Finally, Part IV will discuss whether Canada needs the
deepening insolvency doctrine, or whether it should be rejected on the basis that it is
functionally equivalent to existing remedies in Canadian law.

16 See Neil Abbott, Another Canadian Compromise, Deepening Insolvency in Canada (Paper
presented to the 4th Annual DePaul Symposium and Commercial Law Journal Symposium, Chicago,
2730 April 2006) [unpublished, on file with author]; Russell Silberglied, Deepening Insolvency,
the Next Theory of Liability to Invade Canadian Borders or Making a Retreat Within the U.S.A.?
(Lecture delivered at the 4th Annual Review of Insolvency Law Conference, Quebec City, 30 March
2007) [unpublished]; Fred Myers et al., Shared and Divergent Perspectives from the Bench, the
Regulator and the Bar: Where is Insolvency and Restructuring Practice Heading? (Panel discussion
delivered at the Canadian Institutes 8th Annual Advanced Insolvency Law and Practice, Toronto, 17
18 January 2008) [unpublished].

173

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

I. Canadian Directors Duties to Creditors
Under subsection 122(1)(a) of the Canada Business Corporation Act,17 each
director owes a fiduciary duty to the corporation, sometimes known as a duty of
loyalty, to act honestly and in good faith with a view to the corporations best
interests. Separate from this fiduciary duty, each director and officer also has a duty to
exercise the care, diligence and skill that a reasonably prudent person would exercise
in comparable circumstances pursuant to subsection 122(1)(b) of the CBCA, a
requirement generally referred to as the duty of care.18
Originally, directors had no duties to creditors and could ignore creditors
interests, subject only to tort and contract rules.19 This continued to be the
predominant view in Canada until Re Trizec Corp.,20 which dealt with an application
for approval of a proposed plan of arrangement. Trizec was pivotal because it
signalled a significant shift in the traditional concept of directors duties. Rather than
directors owing duties only to the corporation, Justice Forsyth determined that a
specific duty to shareholders becomes intermingled with a duty to creditors when the
ability of a company to pay its debts becomes questionable.21 The shift toward the
perception that directors duties extend to creditors as a corporation approaches
insolvency gained support with the trial court decision in Peoples,22 in which Justice
Greenberg found the corporations directors personally liable for having breached
their duties to creditors. He relied on U.K., Australian and New Zealand
jurisprudence to determine that Canadian directors duties in subsection 122(1) of the
CBCA should extend to the corporations creditors when the corporation is insolvent
or close to insolvency. However, the Quebec Court of Appeal overturned the trial
judges decision and noted that expanding the scope of directors duties was a
legislative issue, not one for the courts.23

17 Supra note 3.
18 Ibid. Corporate statutes in each province also impose similar duties.
19 Jacob S. Ziegel, Creditors as Corporate Stakeholders: The Quiet Revolutionan Anglo-
Canadian Perspective (1993) 43 U.T.L.J. 511 at 517; Royal Bank of Canada v. First Pioneer
Investments Ltd. (1979), 27 O.R. (2d) 352, 106 D.L.R. (3d) 330 (Sup. Ct.).

20 (1994), 158 A.R. 33, 10 W.W.R. 127 (Q.B.) [Trizec].
21 Ibid. at para. 42.
22 (1998), [1999] R.R.A. 178, 23 C.B.R. (4th) 200 (Qc. Sup. Ct.).
23 Peoples Department Stores Inc. (Trustee of) v. Wise, [2003] R.J.Q. 796 at paras. 95-96, 224
D.L.R. (4th) 509 (C.A.). See also the Peoples Symposium of the Canadian Business Law Journal,
which includes Catherine Francis, Peoples Department Stores Inc. v. Wise: The Expanded Scope of
Directors and Officers Fiduciary Duties and Duties of Care (2005) 41 Can. Bus. L.J. 175; Wayne D.
Gray, A Solicitors Perspective on Peoples v. Wise (2005) 41 Can. Bus. L.J. 184; Warren Grover,
The Tangled Web of the Wise Case (2005) 41 Can. Bus. L.J. 200; Ian B. Lee, Peoples Department
Stores v. Wise and the Best Interests of the Corporation (2005) 41 Can. Bus. L.J. 212; Stphane
Rousseau, Directors Duty of Care after Peoples: Would It Be Wise to Start Worrying about
Liability? (2005) 41 Can. Bus. L.J. 223; Jacob S. Ziegel, The Peoples Judgment and the Supreme
Courts Role in Private Law Cases (2005) 41 Can. Bus. L.J. 236.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

174

The dismissal of the subsequent appeal by the Supreme Court of Canada in
Peoples sharply halted the expansion of directors duties. The Court held that a
directors statutory duty of loyalty to the corporation does not extend to creditors,
even when the corporation is approaching insolvency. Rather, as directors attempt to
alleviate a corporations financial difficulties, they must act with honesty and in good
faith in the best interests of the corporation. In so doing, directors will not have
breached their statutory fiduciary duty, regardless of whether or not they manage to
save the corporation.24 Therefore, it is now settled law in Canada that no director is
statutorily required, or allowed, to make a decision based on any other interest when
discharging his or her fiduciary duty.

The Court specifically considered U.K. law and rejected a similar application in
Peoples. Under English law, it has been the case since the late 1980s that in addition
to the duty to act in the best interest of the company, directors also have duties to
consider creditors interests, both at common law25 and under the statutory
[w]rongful trading provisions.26 Under the wrongful trading provisions, upon an
application by a liquidator, a court may declare directors liable to make personal
contributions to the companys assets in the course of the companys winding up if
the directors failed to have the company cease trading as it approached insolvent
liquidation.27

24 Supra note 1 at para. 67.
25 Paul L. Davies, Gower and Davies Principles of Modern Company Law, 7th ed. (London: Sweet
& Maxwell, 2003) at 373; Andrew R. Keay & Peter Walton, Insolvency Law: Corporate and Personal
(Harlow: Pearson Longman, 2003) at 544. It is worthy of note, however, that there has been no
decision of the House of Lords on this point. The duties developed gradually and were most
definitively extended by the Court of Appeal for England and Wales in 1988 in West Mercia
Safetywear Ltd. (in liq) v. Dodd, in which the court noted the existence of a duty to take into account
creditors interests, but only when the company is approaching insolvency ([1988] B.C.L.C. 250). For
more recent cases, see Official Receiver v. Stern (No 2), [2002] 1 B.C.L.C. 119 at para. 32 (C.A.);
Colin Gwyer & Associates Ltd. v. London Wharf (Limehouse) Ltd., [2002] EWHC 2748 (Ch), [2003] 2
B.C.L.C. 153 at paras. 72-74.

26 Insolvency Act 1986, supra note 2, s. 214(1).
27 The history behind the wrongful trading provisions is worthy of note. Before 1985, when the
wrongful trading provisions were enacted, directors could be held criminally and civilly liable for
fraudulent trading, which required a finding of intent to defraud creditors of the company or creditors
of any other person or for any fraudulent purpose (Companies Act, 1948 (U.K.), 11 & 12 Geo. VI, c.
38, s. 332(1), now s. 213(1) of the Insolvency Act 1986, ibid.). Due to the subjective nature of the
imposition of liability, that law was perceived to be inadequate. See U.K., H.C., Insolvency Law and
Practice: Report of the Review Committee, Cmnd 8558 in Sessional Papers (1981-82) 1 at para.
1782 [Cork Report]. The Cork Committee therefore sought to establish a lower threshold for a finding
of liability by imposing civil liability on directors for wrongful trading, such that an honest but
unreasonable action would leave directors open to personal liability (ibid.). More accountability on the
part of directors would thus be encouraged, requiring them to ensure the presence of adequate funds
prior to making decisions to continue trading, and to take immediate steps to put the company into
liquidation, receivership or administration on the insolvency of the company. The Cork Report
recommended the imposition of an objective test. The standard to be applied to directors would be that

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

There is no equivalent to these wrongful trading provisions in Canada. Following
the Supreme Court of Canadas refusal in Peoples to recognize a duty to creditors as
the corporation approaches insolvency, Canadian creditors may fear insufficient
protection for their interests and, consequently, may be prompted to bring the
American deepening insolvency action into Canadian courts. While the potential
benefit to creditors as a result of the deepening insolvency claim is indirect, because
the action is based on harm done to the corporation, creditors would eventually profit
if money is brought into the corporation by virtue of a successful action.

175

II. Position in the United States

In 1983, the term deepening insolvency was coined when the United States
Court of Appeals for the Seventh Circuit recognized the damage that can be accrued
when management continues to operate an insolvent corporation.28 Since then, the
doctrine has been widely considered and has been the subject of numerous claims. As
indicated earlier, while recent decisions have put the future of the doctrine into
question,29 the contours of the doctrine have nonetheless been taking shape within the
large body of jurisprudence that has accumulated over the last twenty years.

A. What is Deepening Insolvency?

Deepening insolvency is a nonstatutory doctrine that does not appear anywhere
in the Bankruptcy Code.30 The absence of a statutory definition renders the doctrine
uncertain in scope31 and consequently, deepening insolvency has neither been

of the ordinary, reasonable man and what he would have done in the circumstances (ibid. at paras.
1783, 1790).

The Department of Trade and Industry accepted the recommendation for the imposition of
liability for wrongful trading (U.K., H.C., A Revised Framework for Insolvency Law, Cmnd 9175
in Sessional Papers (198384) 1 at 28). It determined that during a winding up, if it was found that
directors had continued to trade and the existing creditors of the company were, as a result, in a worse
financial position or that new, unpaid liabilities had been incurred by the company during that time,
then the directors who knew, or ought to have known, that the company could not reasonably have
avoided that situation would be personally liable for the loss suffered by creditors (ibid.). Due to the
legislative reforms in 198586, the criminal provision became s. 458 of the Companies Act 1985
((U.K.), 1985, c. 6) and the civil sanctions became ss. 213-15 of the Insolvency Act 1986 (supra note
2) for fraudulent and wrongful trading (Davies, supra note 25 at 194).

28 Schacht, supra note 5 at 1350.
29 In addition to the sources cited in supra notes 7-8, see also North American Catholic Educational
Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92 (Del. Sup. Ct. 2007) [Gheewalla]. The
Gheewalla decision determined that creditors have no right to bring a direct claim against directors for
breach of fiduciary duty, and did not comment on deepening insolvency. Nonetheless, some critics are
combining Gheewalla with Trenwick to show the Delaware courts proclivity against finding director
duties to creditors when the company is in the vicinity of insolvency or altogether insolvent.

30 U.S.C. 11 (2000).
31 Neil S. Abbott, Robert Radasevich & Keith J. Shapiro, A Deeper Look at Deepening

Insolvency (2006) 4 DePaul Bus. & Com. L.J. 529 at 529-30.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

176

universally defined nor applied, nor has it been universally accepted in the United
States. However, several important cases have contributed to the development of the
theory, and while these cases have not necessarily served as precedents for all others,
they constitute the theoretical foundation upon which the different conceptions of the
deepening insolvency theory have been constructed. To date, deepening insolvency
has been accepted as an independent cause of action,32 as a cause of action that
piggy-backs onto other claims (namely breach of fiduciary duty),33 or as a theory of
damages.34 Some courts have also completely rejected the theory.35
Directors, officers or other parties who exercise control over the corporation
engage in deepening insolvency when they wrongfully incur further corporate debt
while the corporation is insolvent and has no reasonable prospect of recovering.
Deepening insolvency is premised on the acknowledgment that incurring such debt
harms the corporation. Accordingly, the harm brought about by directors failure to
stop trading under the above circumstances can be avoided through the creation of
personal liability under the doctrine of deepening insolvency.36 The objective of the

32 Although Trenwick has rejected the prospect that deepening insolvency can be used as an

independent cause of action (supra note 8 at 205).

33 This topic will be discussed later. For now, it is sufficient to say that in Rahl v. Bande (328 B.R.
387 (Bankr. S.D.N.Y. 2005)), Sharp v. Hawkins (2004 WL 2792121 (N.D. Cal. 2004) (WL)), and Re
RSL COM Prime-Call Inc. (2003 WL 22989669 (Bankr. S.D.N.Y. 2003) (WL) [Re RSL COM]), the
complainants treated deepening insolvency as a breach of fiduciary duty, claiming that the defendants
had breached their fiduciary duties to the corporation by wrongfully prolonging its life.

34 As a theory of damages, deepening insolvency is seen as a

form of injury to the company and its creditors, compensable under established causes
of action (e.g. breach of fiduciary duty by the companys directors and in respect of the
third parties such as lenders, actions against such persons for aiding and abetting or
conspiring in the breach of the directors fiduciary duties) and measured by the extent
of the companys deepened insolvency (Rostom, Kent & Weerasooriya, supra note
15 at 2).

As a theory of damages, it is usually raised in response to the defense that increased debt injured the
creditors, but did not harm (and actually helped) the corporation (Bondi v. Citigroup, Inc., 2005 WL
975856 at 21 (N.J. Super. L. 2005) (WL) [Bondi]. See also Hanover Corp. of America v. Beckner, 211
B.R. 849 (M.D. La. 1997); Allard v. Arthur Andersen & Co. (USA), 924 F.Supp. 488 (S.D.N.Y. 1996);
Drabkin v. L & L Constr. Assocs., Inc. (In re Latin Inv. Corp.), 168 B.R. 1 at 6 (Bankr. D.D.C. 1993)
[Drabkin].

35 See e.g. Coroles v. Sabey, 2003 UT App 399, 79 P.3d 974 at 983 (Ct. App. Utah 2003) [Coroles];

Bondi, ibid.; Trenwick, supra note 8.

36 Salomon v. Salomon and Co. is commonly (but mistakenly) referenced as the origin of limited
liability ([189599] All E.R. 33, [1897] A.C. 22 (H.L.) [Salomon]). Salomon was based on the
creation of corporate-like personality for English Registered Companies and only dealt with the
limited liability of shareholders and not directors. Limited liability for shareholders in the United
Kingdom was conferred by The Limited Liability Act, 1855 and the term limited liability referred to
the amount remaining unpaid on their shares, as opposed to a reference to their immunity ((U.K.), 18
& 19 Vict., c. 133). Accordingly, in jurisdictions that preclude shares from being issued on a partly-
paid or unpaid basis, the term limited liability is incorrect and shareholder immunity is preferred,
as is found in the CBCA (supra note 3, s. 45). However, limiting the personal liability of directors has

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

liability imposed by the doctrine is to motivate directors to recognize this harm and
cease trading as soon as saving the corporation is no longer a feasible prospect.37 As
the United States Court of Appeals for the Seventh Circuit noted in Schacht:
[A]cceptance of a rule which would bar a corporation from recovering damages
due to the hiding of information concerning its insolvency would create
perverse incentives for wrong-doing officers and directors to conceal the true
financial condition of the corporation from the corporate body as long as
possible.38

177

Without the threat of personal liability, directors may be no worse off even if they
continue to incur debt when the corporation is insolvent. Even if it is unlikely that the
corporation could trade into a profitable financial state, directors have an incentive to
take that chance. If they are successful, they will once again have a profitable
corporation; they will keep their jobs and, if they are also shareholders, regain value
in their shares. If they are unsuccessful, other than the damage done to their
reputations as directors, they will suffer no additional financial loss because the
limitation of their liability ensures that they are not responsible for the corporations
debts.
While the deepening insolvency claim ends up protecting creditors, because their
injury results indirectly from injury to the corporation,39 the actual claim is brought by
the corporation to address the harm that has been done to it.40 Accordingly, the right
of action must belong to the debtor corporation, not to the creditors.41 The injury
suffered in a deepening insolvency situation was defined in Lafferty as an injury to
the Debtors corporate property from the fraudulent expansion of corporate debt and
prolongation of corporate life.42 Generally, additional harm can include artificially
propping up the debtor, which delays bankruptcy.43 Specifically, the injury caused to
the corporation can include the decline in value of the remaining corporate assets
through the incurrence of additional debt.44 It can cause a hastening of bankruptcy
through the dissipation of corporate assets45 and an undermining of the relationships

also been recognized by the law. For a further discussion on the intended beneficiaries of limited
liability, see Christopher C. Nicholls, Liability of Corporate Officers and Directors to Third Parties
(2001) 35 Can. Bus. L.J. 1 at 1-4.

37 Look Chan Ho, On Deepening Insolvency and Wrongful Trading (2005) 20 Journal of

International Banking Law and Regulation 426 at 429.

38 Supra note 5 at 1350.
39 See Re Buildnet, Inc., 2004 WL 1534296 at 2 (Bankr. M.D.N.C.) (WL) [Buildnet].
40 See Abbott, Radasevich & Shapiro, supra note 31 at 538.
41 Lafferty, supra note 6 at 347-49. See also ibid.
42 Ibid. at 347.
43 OHC Liquidation Trust v. Credit Suisse First Boston (In re Oakwood Homes Corp.), 340 B.R. 510

at 532 (Bankr. D. Del. 2006) [Oakwood Homes].

44 Corporate Aviation Concepts, Inc. v. Multi-Service Aviation Corp., 2004 WL 1900001 at 12 (E.D.

Pa. 2004) (WL) [Aviation Concepts].

45 Ibid.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

178

between the corporation and its customers, suppliers, and employees.46 Due to the
broad definition of deepening insolvency, while the claim is usually brought against
directors and officers, it may include other defendants such as lenders or auditors.47
Nevertheless, to fall within the scope of the deepening insolvency doctrine, the
prolongation of the corporations life must usually have been the result of fraud. In
Schacht, the court defined deepening insolvency as involving the fraudulent
prolongation of a corporations life beyond insolvency.48 The court in Lafferty
described it as an injury to the Debtors corporate property from the fraudulent
expansion of corporation debt and prolongation of corporate life,49 while the court in
Corporate Aviation Concepts, Inc. v. Multi-Service Aviation Corp. stated that
deepening insolvency occurs where corporate property is injured through the
fraudulent or concealed expansion of corporate debt and prolongation of corporate
life.50 Some cases have suggested that the deepening insolvency threshold is met
with a finding of negligence.51 However, the court in Kittay v. Atlantic Bank (Re
Global Service Groups LLC)52 held that under the business judgment rule, if directors
and officers continue to operate an insolvent corporation in good faith, they will not
be subject to liability for deepening insolvency.53 Therefore, while it is possible to
argue for deepening insolvency based on negligent conduct, depending on the extent
of the negligence, the business judgment rule could effectively cancel the deepening
insolvency claim, provided that the directors acted diligently and in good faith.

46 Lafferty, supra note 6 at 350.
47 For example, in Official Comm. of Unsecured Creditors v. Credit Suisse First Boston (In re Exide
Technologies) (299 B.R. 732 (Bankr. D. Del. 2003) [Exide Technologies]) and Oakwood Homes
(supra note 43), the deepening insolvency claims were brought against the lenders who exercised
control over the debtor corporation, and in Tabas v. Greenleaf Ventures, Inc. (In re Flagship
Healthcare, Inc.) (269 B.R. 721 (Bankr. S.D. Fla. 2001) [Flagship Healthcare]), the court denied a
motion to dismiss a deepening insolvency claim brought against the debtors auditing firm for having
negligently prepared an auditing report.

48 Supra note 5 at 1350.
49 Supra note 6 at 347.
50 Supra note 44 at 12.
51 In Limor v. Buerger (In re Del-Met Corp.), the court, quoting Jo Ann J. Brighton (Deepening
Insolvency (April 2004) 23 Am. Bankr. Inst. J. 34 at 34), accepted the notion that deepening
insolvency may occur when the defendant negligently prolongs the corporations life (322 B.R. 781 at
812 (Bankr. M.D. Tenn. 2005)). See also Gouiran Holdings, Inc. v. DeSantis, Prinzi, Springer, Keifer
& Shall (In re Gouiran Holdings), 165 B.R. 104 at 107 (E.D.N.Y. 1994) (reversing the grant of a
motion to dismiss on a claim for negligent preparation of financial statements that may have resulted
in the debtor incurring unmanageable debt and filing for bankruptcy protection); Bondi v. Citigroup,
supra note 31; Flagship Healthcare, supra note 47; Re CitX Corp., Inc., 448 F.3d 672 at paras. 9-10
(3d Cir. 2006) (acknowledging the support for the argument but ultimately refusing to expand the
scope of deepening insolvency to include negligence).

52 316 B.R. 451 (Bankr. S.D.N.Y. 2004) [Global Service]. For further discussion of the business

judgment rule, see Part III.

53 Ibid. at 460.

2008]

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

179

B. Tort or Non-Tort?

There are several cases that have contributed to the development of the deepening
insolvency doctrine. The phrase deepening insolvency was pioneered in 1983 in
Schacht, which dealt with an interlocutory appeal from the United States Court for
the District of Delawares denial of the defendants motion to dismiss the claim
brought against them. The plaintiff, a statutory liquidator, claimed that the fraudulent
actions of the defendants, the directors and officers, caused the Corporation, Reserve
Insurance Company (Reserve), to continue conducting business even though it was
insolvent, leading Reserve to accrue greater liabilities and drive it deeper into
insolvency, causing damage to Reserve, its creditors and policy holders.54 The court
upheld the denial of the motion to dismiss, finding that the corporation could be
damaged by the deepening of its insolvency since this circumstance further exposed
the corporate entity to creditor liability.55
Since Schacht, numerous decisions on deepening insolvency have been rendered.

In Lafferty, one of the most influential judgments, a committee of creditors was
authorized to pursue a claim on behalf of the two debtor corporations after a Ponzi
scheme56 was discovered. The claim was brought against the debtors officers,
directors, affiliated corporations, outside professional accountants, and underwriters,
alleging that the third parties had conspired with the debtors management to
fraudulently induce these corporations to issue debt certificates, thereby deepening
the latters insolvencies. The court found that deepening insolvency gives rise to
cognizable injury, injury that can be avoided if the corporation is dissolved in a
timely manner, rather than kept afloat with spurious debt.57 Accordingly, Lafferty
recognized deepening insolvency as a cause of action.58
In Global Service the plaintiff trustee brought a claim for deepening insolvency

against the senior management of Global Service Group, LLP (Global) and against its
lender, Atlantic Bank. The trustee alleged that the management had allowed Global to
operate and incur debt while it was insolvent, and that [b]y prolonging the debtors

54 Supra note 5 at 1345.
55 Ibid. at 1350.
56 A Ponzi scheme is a

fraudulent investment scheme in which money contributed by later investors generates
artificially high dividends for the original investors, whose example attracts even larger
investments. Money from the new investors is used directly to repay or pay interest to
earlier investors, [usually] without any operation or revenue-producing activity other
than the continual raising of new funds (Blacks Law Dictionary, 8th ed., s.v. Ponzi
scheme).

57 Supra note 6 at 350. Subsequently Exide Technologies relied on the reasoning in Lafferty to
recognize a cause of action for deepening insolvency in Delaware (supra note 47). In Oakwood
Homes the United States Bankruptcy Court for the District of Delaware also followed Lafferty to
determine that Delaware, New York and North Carolina courts would recognize deepening insolvency
as a cause of action (supra note 43 at 531).

58 Ibid. at 351.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

180

corporate life and incurring more debt, the [management] deepened Globals
insolvency, and reduced any potential recovery for the creditors of the debtors
bankruptcy estate.59 The trustee also alleged that Atlantic Bank knew or should have
known that Global, an insolvent corporation, would be unable to pay back the money
loaned to it.60 The United States Bankruptcy Court for the Southern District of New
York found that the prolongation of an insolvent corporations life, without more,
would neither constitute an independent tort nor a theory of damages.61 Rather, to
successfully claim deepening insolvency, a claimant must show that the defendant
prolonged the companys life in breach of a separate duty, or committed an actionable
tort that contributed to the continued operation of a corporation and its increased
debt.62 Simply put, the court found directors to be under no duty to liquidate an
insolvent corporation, and failure to do so does not open them up to liability. Rather,
the decision to continue operating an insolvent corporation is protected by the
business judgment rule, which can only be overcome with allegations that the
fiduciary had acted in bad faith or with fraudulent intent.63
Similarly, the court refused to accept deepening insolvency as a claim in Bondi,

commenting that it is the responsibility of the legislature or the Supreme Court of the
United States to create new causes of action.64 The Court of Appeals for Utah also
refused to recognize a claim for deepening insolvency that had been put forth by the
plaintiff as a theory of damages, finding that while deepening insolvency might harm
the shareholders of the corporation, it does not harm the corporation itself.65 Finally,
the Court of Chancery of Delaware refused to recognize the claim as a coherent
concept, noting that the law already required directors of an insolvent corporation, as
fiduciaries, to consider the interests of creditors.66

59 Supra note 52 at 456.
60 Ibid. at 455.
61 Ibid. at 458.
62 Ibid.
63 Ibid. at 461.
64 Supra note 34.
65 Coroles, supra note 35 at 983.
66 Trenwick, supra note 8 at 174. In the United States, directors owe their fiduciary duties of care
and loyalty to the corporation and its shareholders. See Smith v. Van Gorkom, 488 A.2d 858 at 872
(Del. Sup. Ct. 1985); Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 at 955 (Del. Sup. Ct. 1985)
[Unocal]; Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 at 179 (Del. Sup. Ct.
1986); Aronson v. Lewis, 473 A.2d 805 at 811 (Del. Sup. Ct. 1984) [Aronson]. In a solvent
corporation, directors are expected to act in a manner that maximizes the value of the corporation for
the corporation and its owners, the shareholders. However, once a corporation enters the vicinity of
insolvency, the Delaware Court of Chancerys decision in Credit Lyonnais Bank Nederland, N.V. v.
Pathe Communications Corp. established that those duties shift to encompass creditors interests
(1991 WL 277613 (Del. Ch. 1991) (WL) [Credit Lyonnais]). While some commentators have
interpreted Credit Lyonnais to have created a new duty owed directly to creditors upon a corporations
insolvency, the prevailing view has determined that there is no specific duty to creditors at any time
and the duty to consider creditors interests is one that is owed to the corporation. See Production

181

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

In summary, while most American courts that have accepted the claim are in
agreement that deepening insolvency involves the fraudulent (or sometimes
negligent) prolongation of the corporations life, there is no clear delineation with
regard to how deepening insolvency can be used as a claim. Even if the courts were
to settle on treating deepening insolvency as a tort claim, its elements would still have
to be defined. In addition, its treatment as a tort claim would necessitate the difficult
task of showing causation and the amount of harm done by the tortthe amount by
which the corporations insolvency was deepened.67

The doctrinal uncertainty of the deepening insolvency doctrine, and its potential
overlap with several Canadian doctrines that could also be used to address the
wrongful prolongation of a corporations life, indicate that Canada should not be too
hasty to adopt deepening insolvency.

III. Deepening Insolvency and the Business Judgment Rule

Imposing liability on directors of an insolvent company raises concerns that
courts may, through the wisdom of hindsight, find directors liable for implementing,
or failing to implement, certain policies at the time the corporation began
encountering financial difficulty. Should that happen, directors fear of liability could
lead to overdeterrence, or what has been described as a blanket duty to liquidate
upon insolvency:68 directors, concerned about incurring liability for the wrongful
prolongation of the corporations life during their attempts to rescue it, may forego
this opportunity and liquidate too early. Hence, while the deepening insolvency
doctrine seeks to compel directors to take steps to minimize the loss to the company
only once they know there is no reasonable prospect of avoiding insolvent
liquidation, directors may nonetheless be inclined to put the company into liquidation
earlier than necessary in order to ensure the avoidance of liability.
While concerns over the potential diminishment of the business judgment rule if
deepening insolvency were to be adopted may be warranted, the concern about
exposing directors to additional liability is somewhat indefensible. From a policy

Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772 (Del. Ch. 2004). Most recently, Gheewalla
clarified where directors duties lie at varying times. Directors owe their fiduciary duties to the
corporation when the company is solvent, a position that does not change when the company is in the
zone of insolvency (supra note 29 at 101). When the corporation is insolvent, however, creditors
have standing to bring derivative actions on behalf of the corporation for breach of fiduciary duties
(ibid. at 101-02). See also Dianne F. Coffino & Charles H. Jeanfreau, Delaware Hits the Brakes: The
Effect of Gheewalla and Trenwick on Creditor Claims (2008) 17 Norton 63.

67 See Jonathan M. Landers, Deepening Insolvency Comes of Age (2006) 236 N.Y.L.J. 4; Daniel
E. Harrell, Pandoras Bankruptcy Tort: The Potential for Circumvention of the Business Judgment
Rule Through the Tort Theory of Deepening Insolvency (2005) 36 Cumb. L. Rev. 151 at 152. See
also Jay R. Bender, Deepening Insolvency in Alabama: Is it a Tort, a Damages Theory, or Neither of
the Above? The Alabama Lawyer (May 2005) 188 at 195 (discussing the uncertainty of the elements
of the claim).

68 Abbott, supra note 16 at 11.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

182

perspective, although deepening insolvency could potentially expand the realm of
liability for third-party professionals, it likely would not do so for directors.

Short of engaging in fraudulent or wrongful conduct, a board of directors is under
no obligation to liquidate an insolvent company,69 a concept that would not change
with the adoption of the deepening insolvency doctrine. Rather, as the court in
Trenwick stated, even when the company is insolvent, the board may pursue, in good
faith, strategies to maximize the value of the firm,70 an approach that is consistent
with the goals underlying Chapter 11 and that can result in turning the corporation
into a profitable entity.71 If directors implement a diligent and good-faith strategy
geared toward saving the company, even one that causes the corporation to incur
more debt, the behaviour will not give rise to a cause of action because the directors
will be protected under the business judgment rule.72 The business judgment rule, a
presumption that in making a business decision the directors of a corporation acted
on an informed basis, in good faith and in the honest belief that the action taken was
in the best interests of the company,73 ensures that courts refrain from substituting
their own judgment for that of directors so long as the directors were prudent, diligent
and carried out the decision in good faith. A finding of fraud, however, which is
required by most courts for a deepening insolvency action as it currently stands,
would automatically rebut the business judgment rule, which only applies to
decisions carried out in good faith. The protection provided under the business
judgment rule relieves the concerns about overdeterrence.
Notably, in support of this point, the behaviour targeted by deepening insolvency,
the fraudulent concealment of the corporations faltering financial status in an effort
to acquire more corporate debt, has most commonly been caught by other doctrines,
such as fraud or breach of fiduciary duty. This duplication was acknowledged in
Trenwick:

The rejection of an independent cause of action for deepening insolvency does
not absolve directors of insolvent corporations of responsibility. Rather, it
remits plaintiffs to the contents of their traditional toolkit, which contains,
among other things, causes of action for breach of fiduciary duty and for fraud.
…
No doubt the fact of insolvency might weigh heavily in a courts analysis of, for
example, whether the board acted with fidelity and care in deciding to
undertake more debt to continue the companys operations, but that is the

69 Support for this proposition is much clearer in the United States than in Canada. In the United
States, courts have clearly articulated this principle. See Trenwick, supra note 8 at 204; Global
Service, supra note 50 at 460. In Canada, as the corporation approaches insolvency, directors must
continue acting in the best interest of the corporation, an obligation capable of encompassing the
American approach.

70 Ibid. at 204.
71 Ibid.; Global Service, supra note 52 at 460.
72 See e.g. Trenwick, ibid. at 205; Global Service, ibid.
73 Aronson, supra note 66 at 812; Unocal, supra note 66 at 954 (citing Aronson).

2008]

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

183

proper role of insolvency, to act as an important contextual fact in the fiduciary
duty metric. In that context, our law already requires the directors of an
insolvent corporation to consider, as fiduciaries, the interests of the
corporations creditors who, by definition, are owed more than the corporation
has the wallet to repay.74

If a lowered threshold were to become the acceptable norm for asserting a
deepening insolvency claim, such that a finding of fraud were no longer required, the
issue would be with regard to how the business judgment rule would apply to a
deepening insolvency claim. The answer would depend on the level of negligence
that would be required to meet the lowered threshold. If only basic negligence is
required, the business judgment rule would likely become inapplicable since the
claim itself would require courts to examine the very types of decisions specifically
precluded from examination under the rule, namely those made negligently, even if
made diligently and in good faith.75 It is likely the case, however, that these fears are
unfounded. A threshold requiring negligence for a deepening insolvency claim would
likely be limited to situations involving extreme negligence, lacking diligence and
good faith, in which case the application of the business judgment rule as it currently
stands would remain intact.
Potential problems may arise with regard to the coverage provided by the

business judgment rule. The business judgment rule can only protect directors
exercising managerial authority. The deepening insolvency action has been brought
not only against directors, but also against third-party professionals who provide
advice to directors and who would not benefit from the protection of the business
judgment rule.76 Finally, if the deepening insolvency action were to be classified as an
independent tort, and not a business decision, the business judgment rule may not
apply.77
Concerns regarding overdeterrence do raise several important issues. However, if

courts approach decisions relevant to deepening insolvency claims like any other
managerial decision, and if the threshold leans more toward fraudulent conduct rather
than negligent behaviour, the concerns are not as significant as they first appear.

74 Supra note 8 at 205. See generally David C. Thompson, A Critique of Deepening Insolvency, a

New Bankruptcy Tort Theory (20062007) 12 Stan. J. L. Bus. & Fin. 536 at 543-46.

75 See Harrell, supra note 64 at 153; Thompson, supra note 66 at 546.
76 Kevin Patrick McGuinness, Canadian Business Corporations Law, 2d ed. (Markham, Ont.:

LexisNexis, 2007) at paras. 11.15-11.25 (discussing the business judgment rule).

77 See Harrell, supra note 67 at 153. The business judgment rule applies to business decisions and
strategies of directors and has, for the most part, been utilized when judges assess whether directors
have carried out their duties to the corporation. It is unclear whether the business judgment rule would
protect directors if deepening insolvency were to be classified as a tort, independent of directors
duties.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

184

IV. Analysis: Canadas Adoption of Deepening Insolvency?

In considering whether deepening insolvency has a place in Canadian
jurisprudence, both muddying the Canadian legal waters with a doctrine that has yet
to be defined in its country of origin as well as the potential danger of overlap
between an American legal doctrine and existing domestic law should give us pause
for consideration. Indeed, the doctrine would add little to Canadian law because the
recognition of deepening insolvency would mean the duplication of several
obligations that already exist for Canadian directors.

A. Oppression Remedy: A Functionally Equivalent Canadian Doctrine

1. What is the Oppression Remedy?

In Peoples, the Supreme Court of Canada claimed that directors duties toward

creditors are not necessary, given that creditors already have the oppression remedy.78
The oppression remedy can be granted when the court is satisfied that the corporation
or its directors acted in a way that is oppressive or unfairly prejudicial to, or that
unfairly disregards the interests of, any security holder, creditor, director, or officer.79
Oppressive conduct has been defined as burdensome, harsh and wrongful,
unfairly prejudicial as inequitable or unjust, and unfairly disregarding as
unjustly or without cause … paying no attention to the interests of creditors.80

2. Differences between the Oppression Remedy and Deepening

Insolvency and Whether They Matter

The deepening insolvency doctrine and the oppression remedy differ with regard
to the identity of the plaintiffs and defendants and the quantification of damages.
Regardless of these differences, the oppression remedy, provided it is slightly

78 See Peoples, supra note 1 at paras. 47-51. Unsecured creditors do not have automatic standing to
pursue the oppression remedy but the courts have been known to grant them status to bring a claim.
The requirements that have to be met are set out throughout this section.

79 The requirements are set out in s. 241(2)(c) of the CBCA (supra note 3) and under all provincial
statutes except Prince Edward Islands. See Business Corporations Act, R.S.A. 2000, c. B-9, s. 242(2)
[ABCA]; Corporations Act, R.S.M. 1987, c. C255, C.C.S.M. c. C255, s. 234(2); Business
Corporations Act, S.N.B. 1981, c. B-9.1, s. 166(2); Corporations Act, R.S.N.L. 1990, c. C-36, s.
371(2); Companies Act, R.S.N.S. 1989, c. 81, s. 5(2); Business Corporations Act, R.S.O. 1990, c.
B.16, s. 248(2) [OBCA]; Business Corporations Act, R.S.S. 1978, c. B-10, s. 234(2); Business
Corporations Act, R.S.Y. 2002, c. 20, s. 243(2); The Business Corporations Act of British Columbia
protects only shareholders or any other person whom the court considers to be [appropriate] (S.B.C.
2002, c. 57, ss. 227(2), 228(1)).

80 Heap Noseworthy Ltd. v. Didham (1996), 137 Nfld. & P.E.I.R. 240 at para. 15, 29 B.L.R. (2d) 279
(Nfld. S.C.(T.D.)); Westfair Foods Ltd. v. Watt, 106 A.R. 40 at paras. 46-61, [1990] 4 W.W.R. 685
(Q.B.); Stech v. Davies, 80 A.R. 298 at paras. 14-20, [1987] 5 W.W.R. 563 (Q.B.). The requirements
for an unsecured creditor to obtain complainant status will be discussed in the next section.

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

broadened, can serve the same purpose as the deepening insolvency doctrine,
rendering the latter unnecessary in Canadian law. In fact, the Court of Queens Bench
of Manitoba has already suggested that misleading creditors with regard to the
corporations financial status, when directors know or ought to know that the
corporation is insolvent or becoming insolvent, classifies as oppressive or unfairly
prejudicial conduct.81

185

a.

Identity of the Plaintiffs

The first difference arises with regard to the identity of the plaintiffs. The theory
behind the deepening insolvency doctrine is that the claim must necessarily involve
harm done to the corporation, leading to the requirement that only a corporation, or
someone on the corporations behalf, can bring an action for deepening insolvency.82
The oppression remedy is broader such that virtually anyone can be granted status as
a proper person83 to pursue the remedy at the courts discretion. The definition of
proper person has been broadly interpreted to include creditors,84 and Canadian
creditors have been allowed to bring applications for the remedy on numerous
occasions,85 even though unsecured creditors do not have the status as of right since
they are not included in the statutory definition of complainant under the CBCA.86
Courts have granted the necessary standing to Canadian creditors, and to trustees
representing them, in cases in which directors failed to consider their interests.87
The oppression remedy was enacted, inter alia, to protect minority shareholders

reasonable expectations, as their exclusion from elections or general meetings

81 TCT Logistics Inc. v. Osborne (2001), [2002] 1 W.W.R. 742 at para. 11, 159 Man. R. (2d) 147

(Q.B.) [TCT Logistics cited to W.W.R.].

82 The party acting on the corporations behalf will be a committee of creditors (see e.g. Lafferty,
supra note 6; Exide Technologies, supra note 47) or the bankruptcy trustee (see e.g. Global Service,
supra note 52). In Trenwick, a litigation trust pursued the claims against directors, former directors and
advisors of the corporation (supra note 8).

83 CBCA, supra note 3, s. 238(d).
84 Janis P. Sarra & Ronald B. Davis, Director and Officer Liability in Corporate Insolvency: A
Comprehensive Guide to Rights and Obligations (Markham, Ont.: Butterworths, 2002) at 35. Ontario
is an example of a jurisdiction to which this applies. In Alberta, however, legislation has specified that
a creditor can be a complainant, subject to the courts discretion. See ABCA, supra note 79, s. 239.

85 See Olympia & York Developments Ltd. (Trustee of) v. Olympia & York Realty Corp. (2001), 16
B.L.R. (3d) 74, 28 C.B.R. (4th) 294 (Ont. Sup. Ct.), affd (2003), 68 O.R. (3d) 544, 180 O.A.C. 158
(C.A.) [Olympia] (finding the trustee in bankruptcy to be a proper complainant and allowing him to
pursue the oppression remedy in the interests of the creditors, because his primary obligation was to
protect the creditors); Levy-Russell Ltd. v. Shieldings Inc. (1998), 41 O.R. (3d) 54, 165 D.L.R. (4th)
183 (Ct. J. (Gen. Div.)) [Levy-Russell cited to O.R.]; Danylchuk v. Wolinsky, 2007 MBQB 65, [2007] 6
W.W.R. 453 at para. 22, 30 B.L.R. (4th) 215 [Danylchuk].

86 Supra note 3, s. 1.
87 Olympia, ibid.; Dylex Ltd. (Trustee of) v. Anderson (2003), 63 O.R. (3d) 659 (Sup. Ct.).

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

186

rendered them unable to make managers account for their actions.88 Creditors are in a
similar position: they do not elect directors, but directors can act in ways that
prejudice them as the company approaches insolvency.89 Accordingly, complainant
status can be granted to an applicant if the act or conduct of the directors or
management of the corporation which is complained of constituted a breach of the
underlying expectation of the applicant arising from the circumstances in which the
applicants relationship with the corporation arose.90
Prior to Peoples, creditors usually brought successful oppression remedy claims

in cases where directors of closely held corporations transferred assets beyond
creditors reach; generally, the remedy was unavailable in cases in which the
corporation was mismanaged by directors.91 However, since Peoples, the potential for
protection of creditor interests lies in the unfairly disregards or unfairly
prejudicial portion of the remedy and determining whether managerial actions fall
into those categories will thus depend on how the courts define creditors reasonable
expectations.92
Determining a creditors underlying expectation involves an inquiry into
whether, inter alia, the creditor entertain[ed] an expectation that, assuming fair
dealing, its chances of repayment would not be frustrated by the kind of conduct
which subsequently was engaged in by the management of the corporation.93 It also
involves an inquiry into whether the creditor was prevented from taking steps, when
it entered into the credit agreement, to protect his or its interests against the
occurrence of which he or it now complains.94
A creditor will not be granted complainant status if its interests are too remote or
where the complaints of a creditor have nothing to do with the circumstances giving
rise to the debt[,] or if the creditor is not proceeding in good faith.95 Generally, the
remedy is available to a creditor when directors or management have been using the

88 Janis Sarra, The Oppression Remedy: The Peoples Choice in Janis P. Sarra, ed., Annual Review

of Insolvency Law 2005 (Toronto: Thomson Carswell, 2006) 111 at 133 [Sarra, Peoples Choice].

89 Levy-Russell, supra note 85 at para. 30; Re MacRae and Daon Development Corp. (1984), 10
D.L.R. (4th) 216 at 224-25, 54 B.C.L.R. 235 (S.C.) [Re Daon]; Jacobs Farms Ltd. v. Jacobs, [1992]
O.J. No. 813 (Ct. J. (Gen. Div.) (QL)) [Jacobs Farms].

90 First Edmonton Place Ltd. v. 315888 Alberta Ltd. (1988), 60 Alta. L.R. (2d) 122 at 152, B.L.R. 28
(Q.B.), appeal adjourned (1989), [1990] 2 W.W.R. 670, 71 Alta. L.R. (2d) 61 (C.A.) [First Edmonton
cited to Alta. L.R.].

91 Sarra, Peoples Choice, supra note 88 at 132.
92 Ibid. at 132-35.
93 First Edmonton, supra note 90 at 152. See also David Thomson, Directors, Creditors and
Insolvency: A Fiduciary Duty or a Duty Not To Oppress? (2000) 58 U.T. Fac. L. Rev. 31 (tracing the
jurisprudence that has established the legitimate interest test). For an application of the test, see Re
Daon, supra note 89; Jacobs Farms, supra note 89; Royal Trust Corp. of Canada v. Hordo (1993), 10
B.L.R. (2d) 86, 41 A.C.W.S. (3d) 809 (Ont. Ct. J. (Gen. Div.)) [Hordo cited to B.L.R.]; Levy-Russell,
supra note 85.

94 First Edmonton, supra note 90 at 152.
95 Hordo, supra note 93 at para. 14.

187

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

corporation to commit fraud on the creditor, or to protect a creditors underlying
reasonable expectation of repayment when such expectation is frustrated by the
conduct of management.96 Bad faith need not be proven for the courts to find
oppressive conduct.97
Allowing the oppression remedy to be brought by creditors is the way in which
the remedy may be employed to achieve the results made available by the deepening
insolvency doctrine. Even though the corporate plaintiff in a deepening insolvency
claim seeks to right the harm done to itself, such a claim still indirectly protects
creditors because their injury results indirectly from injury to the corporation.98
Further, it indirectly benefits the creditors because the money gained from a
successfully prosecuted action goes into the debtors estate and back out to repay the
creditors:

[A] corporation can suffer an injury unto itself, and any claim it asserts to
recover for that injury is independent and separate from the claims of
shareholders, creditors, and others. We think it is irrelevant that, in bankruptcy,
a successfully prosecuted cause of action leads to an inflow of money to the
estate that will immediately flow out again to repay creditors.99

Therefore, the identities of the plaintiffs are merely procedural differences and do not
lead to substantially different outcomes between the doctrines.

b.

Identity of the Defendants

The second difference between the doctrines arises with regard to the identity of

the defendants. As discussed above, the breadth of the deepening insolvency doctrine
allows anyone who participated in the deepening insolvency of the corporation to be
named as a defendant. While a claim for an oppression remedy is generally brought
against directors or the corporation (or both), it is possible to interpret the oppression
remedy in a similarly broad context and thus to allow for the joining of third parties
as defendants. Subsection 241(2) of the CBCA allows for a complainant to make an
application under the following circumstances:

(1) A complainant may apply to a court for an order under this section.
(2) If, on an application under subsection (1), the court is satisfied that in

respect of a corporation or any of its affiliates

result,

(a) any act or omission of the corporation or any of its affiliates effects a

96 First Edmonton, supra note 90 at 152. This point, as made in First Edmonton, is referred to in
Bull HN Information Systems Ltd. v. L.I. Business Solutions Inc. (1994), [1995] 161 A.R. 268 at para.
2, 23 Alta. L.R. (3d) 186 (Q.B.).

97 Sidaplex-Plastic Suppliers Inc. v. Elta Group Inc. (1998), 40 O.R. (3d) 563, 162 D.L.R. (4th) 367

98 Buildnet, supra note 39 at 7.
99 Lafferty, supra note 6 at 348-49.

(C.A.).

188

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

[Vol. 53

(c) the powers of the directors of the corporation or any of its affiliates are

(b) the business or affairs of the corporation or any of its affiliates are or

have been carried on or conducted in a manner, or

or have been exercised in a manner
that is oppressive or unfairly prejudicial to or that unfairly disregards the
interests of any security holder, creditor, director or officer, the court may make
an order to rectify the matters complained of.100

The powers granted under the oppression remedy are significant and courts are
granted very broad discretionary power to award any interim or final order [they]
think[] fit … 101 The provision widely targets acts or omissions of the corporation,102
the business or affairs of the corporation,103 and the powers of the directors.104
And, even though the statute does not explicitly provide for bringing a claim against
third parties, such a claim can arguably fall under the business or affairs portion of
the provision. Affairs of the corporation, as defined by the CBCA, means the
relationships among a corporation, its affiliates and the shareholders, directors and
officers of such bodies corporate but does not include the business carried on by such
bodies corporate.105 However, business is not defined.106 Arguably, since affairs
refers to the relationships within the corporation and between the insider parties
enumerated in subsection 241(2) of the CBCA, business could encompass those
relationships between the corporation and the outsiders who inform, assist and are
relied upon by those conducting the affairs of the corporation, such as auditors,
accountants, lawyers and lenders. Bruce Welling has also argued that the phrase
business and affairs includes all decisions made by a corporation,107 and Justice
Doherty, in Budd, noted that the provision serves as a judicial brake against abuse of
corporate powers, particularly, but not exclusively, by those in control of a
corporation and in a position to force the will of the majority on the minority.108
Directors are not presumed to be experts in conducting corporate business; it is
expected they will rely on the advice and reports of parties outside the corporation to
perform acts for, and on behalf of, the corporation. In summary, while courts have yet

100 Supra note 3, ss. 241(12).
101 Ibid., s. 241(3)(j); Sidaplex-Plastic Suppliers, Inc. v. Elta Group Inc. (1995), [1996] 131 D.L.R.
(4th) 399 at 406, 25 B.L.R. (2d) 179 (Ont. Ct. J. (Gen. Div.)); Budd v. Gentra Inc. (1998), 111 O.A.C.
288 at para. 44, 43 B.L.R. (2d) 27 (C.A.) [Budd cited to O.A.C.].

102 Ibid., s. 241(2)(a).
103 CBCA, ibid., s. 241(2)(b).
104 Ibid., s. 241(2)(c).
105 Ibid., s. 2.
106 The legislature specifically refrained from defining business and expected the courts to
develop a definition. See Proceedings of the Standing Senate Committee on Banking, Trade and
Commerce, 37th Leg., 1st sess., No. 1 (1 March 2001) at 1:19-20, online: Parliament of Canada
.

107 Bruce Welling, Corporate Law in Canada: The Governing Principles, 3d ed. (London, Ont.:

Scribblers, 2006) at 540.

108 Supra note 101 at para. 32 [emphasis added].

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

to develop a definition for business in the CBCA, it could be interpreted to include
the activities conducted by third parties to inform and influence the corporation.

189

c. Quantifying Damages

Finally, quantifying damages will pose problems under both the U.S. and
Canadian doctrines, but the principles of quantification offered by the oppression
remedy give courts broad discretion to make an order.

The principles that drive a damages qualification for deepening insolvency are as
follows: (1) Dissipation of assets or increased debt load and (2) impact on business
operations and relationships.109 But while it may be simple to articulate the
principles, the actual determination of the loss of value to the corporation as a result
of the deepening of its insolvency will prove to be a factually difficult process.
Drabkin found that damages resulting from keeping the debtor alive while insolvent
are compensatory, but also that proving such damages remains difficult.110
Commentators have noted that causation problems arise in trying to determine which
assets were dissipated as a result of directors actions and which would have occurred
regardless of those actions, while also noting that an increase in the amount of debt
does not necessarily translate into damage to the corporation.111
However, as stated earlier, the oppression remedy gives the court broad discretion
to award any interim or final order it thinks fit, including … an order compensating
an aggrieved person.112 The defendant does not need to have made a profit from the
oppression113 and directors can be held personally liable.114 Further, the CBCA
specifies a compensatory award, which courts have granted in both tort and contract
measures both as a means of returning the plaintiff to the place it occupied before the

109 Kyung S. Lee, James D. McCarthy & Erin E. Jones, Deepening Insolvency DoctrineAn
Emerging Remedy Against Contemporary Corporate Malfeasance (Paper presented to the 23rd
Annual Bankruptcy Conference, 1819 November 2004) at 13 [unpublished, on file with author]; Fla.
Dept of Ins. v. Chase Bank of Tex. N.A., 274 F.3d 924 at 935 (5th Cir. 2001) [Chase Bank] (discussing
the principle of dissipation of assets only).

110 Drabkin, supra note 34 at 13.
111 See ibid., citing Chase Bank, supra note 109; Phil C. Appenzeller, Jr. & Ross H. Parker,
Deepening Insolvency Part I: A Challenging New Theory or Just the Search for a Deeper Pocket?
(Paper presented at the T.M.A. 2005 Spring Conference, 912 March 2005) at 18-19 [unpublished, on
file with author]. In Bookland of Maine v. Baker, Newman & Noyes, LLC the court instructed the jury
to grant damages for the legal and administrative costs sustained in the bankruptcy proceedings, and
for the loss in value to the company up until the date it filed for bankruptcy that the jury could
attribute to the defendant (271 F. Supp. 2d 324 at 326 (D. Me. 2002). The loss in value proved to be
difficult and when the jury made an award, the court found it to be based on erroneous principles and
ordered a new trial on damages.

112 CBCA, supra note 3, s. 241(3)(j).
113 Meyer v. Scottish Co-Operative Wholesale Society Ltd., [1957] Sess. Cas. 110, affd [1958] 3 All

E.R. 66 (H.L.); Clemens v. Clemens Brothers Ltd., [1976] 2 All E.R. 268 (Ch.D.) at 281-82.

114 Danylchuk, supra note 85 at para. 22.

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

190

damage occurred115 and as a way to account for the plaintiffs expectation interest.116
Courts have also suggested that punitive damages can be awarded for deterrence
purposes.117 In any event, seeking to implement a compensatory damage award where
the defendant has continued to operate an insolvent company likely involves the same
type of calculation employed by American courtsdissipated assets and increased
debt load, as well as legal and administrative costs, must all be determined.

[Vol. 53

3. Conclusion on Oppression Remedy

The oppression remedy, as it exists, is capable of addressing the harm targeted by
the deepening insolvency doctrine in the United States. While the interpretation
proposed above may require courts to expand their understanding and application of
the statutory oppression remedy, doing so would provide the benefit of developing
the oppression remedy to deal with these situations, as opposed to stifling its
development by importing a narrower and ill-defined doctrine from the United States.
Importation of the deepening insolvency doctrine would require Canadian directors to
engage in the difficult task of considering two similar, but not identical, doctrines
alongside one another when carrying out their duties. This would inevitably raise
concerns about the overlap and divergence between the doctrines. Canadas
familiarity with the oppression remedy, and the fact that it has already been
designated by the Supreme Court of Canada as appropriate for dealing with situations
in which the corporation is in the vicinity of insolvency, point to the benefits of
expanding its use rather than bringing in the deepening insolvency doctrine.

A. Claim for Breach of Duty: Another Functionally Equivalent

Canadian Doctrine

The deepening insolvency doctrine may be rendered extraneous by yet another
Canadian legal principle. In Canada and the United States, officers and directors are
fiduciaries to the corporation.118 Indeed, in the United States, several claims have
treated the doctrine of deepening insolvency as a breach of fiduciary duty,

115 Sparling v. Javelin International Ltd., [1986] R.J.Q. 1073 (Sup. Ct.).
116 American Reserve Energy Corp. v. McDorman (1999), [2000] 183 Nfld. & P.E.I.R. 40, 48 B.L.R.
(2d) 167 (Nfld. S.C.T.D.) at 218-20, varied as to quantum of damages, 2002 NFCA 57, 217 Nfld. &
P.E.I.R. 7, 29 B.L.R. (3d) 161.

117 C.I.L. Inc. v. Vilar Industries Ltd. (1991), 72 Man. R. (2d) 245 at 258-59, 25 A.C.W.S. (3d) 1233
(Q.B.); Brown v. MacFarland (1988), 10 A.C.W.S. (3d) 270 (Ont. S.C.), stayed on appeal pending
trial of issues (1989), 16 A.C.W.S. (3d) 13 at 14 (S.C.(A.D.)). See also Waxman v. Waxman (2002), 25
B.L.R. (3d) 1, affd (2003), 44 B.L.R. (3d) 156 (Ont. C.A.) (holding that the same principles are
applicable in awarding punitive damages under the oppression remedy as under a claim for breach of
fiduciary duty).

118 Zwicker v. Stanbury, [1953] 2 S.C.R. 438, 1. D.L.R. 257; Canadian Aero Service Ltd. v.
OMalley, [1974] 1 S.C.R. 592, 40 D.L.R. (3rd) 371; Corcoran v. Frank B. Hall & Co., Inc., 545
N.Y.S.2d 278 at 283 (N.Y. App. Div. 1989).

191

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

maintaining that the defendants breached their fiduciary duties to the corporation by
wrongfully prolonging its life.119 Classifying claims in this way begs the question of
the necessity of the deepening insolvency doctrine at all. However, regardless of the
position taken in the United States, the deepening insolvency doctrine may be
unnecessary in Canada due to the existing statutory fiduciary duties and duties of care
of Canadian directors.

The deepening insolvency doctrine targets harm to the corporation. The most
similar Canadian doctrine would therefore be the fiduciary duty owed to the
corporation. Under paragraph 122(1)(a) of the CBCA, directors have a fiduciary duty,
sometimes known as the duty of loyalty, to act honestly and in good faith with a view
to the corporations best interests. By virtue of this duty, directors must be loyal to the
corporation and put its interests before their own.120 The duty is specifically to the
corporation; directors, in acting in the best interests of the corporation, can
acknowledge the general existence of other interests, including those of employees,
shareholders, creditors, and the community,121 but that does not detract from the fact
that directors owe their fiduciary duties to the corporation at all times, even when it
approaches insolvency or becomes insolvent.122
In Peoples, the Supreme Court of Canada confirmed that a directors statutory

duty of loyalty to the corporation does not extend to creditors, and does not change to
encompass creditors when the corporation is approaching the realm of insolvency. In
addition, even if the directors do not manage to save the corporation, acting honestly
and in good faith precludes them from breaching their statutory fiduciary duty. The
Court held:

The various shifts in interests that naturally occur as a corporations
fortunes rise and fall do not, however, affect the content of the fiduciary duty
under s. 122(1)(a) of the CBCA. At all times, directors and officers owe their
fiduciary obligation to the corporation. The interests of the corporation are not
to be confused with the interests of the creditors or those of any other
stakeholders. …

The directors fiduciary duty does not change when a corporation is in the
nebulous vicinity of insolvency. That phrase has not been defined; moreover,
it is incapable of definition and has no legal meaning. What it is obviously
intended to convey is a deterioration in the corporations financial stability. In
assessing the actions of directors it is evident that any honest and good faith

119 See Rahl v. Bande, supra note 33; Sharp v. Hawkins, supra note 33; Re RSL COM, supra note

33; and Global Service, supra note 52.

120 Thomson, supra note 93 at 32.
121 Teck Corp. v. Millar (1972), [1973] 33 D.L.R. (3d) 288 at 314, [1973] 2 W.W.R. 385 (B.C.S.C.)
[Millar]. Millar was approved by Re Olympia & York Enterprises Ltd. and Hiram Walker Resources
Ltd. ((1986), 59 O.R. (2d) 254 at 271, 37 D.L.R. (4th) 193), and restated again in Peoples (supra note
1 at para. 42).

122 Peoples, ibid. at paras. 46, 67; Air Canada Pilots Assn. v. Air Canada Ace Aviation Holdings Inc.

(2007), 26 B.L.R. (4th) 124 at para. 86, 57 C.C.P.B. 204 (Ont. Sup. Ct.).

192

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

[Vol. 53

attempt to redress the corporations financial problems will, if successful, both
retain value for shareholders and improve the position of creditors. If
unsuccessful, it will not qualify as a breach of the statutory fiduciary duty.123

As fiduciaries to the corporation, directors occupy positions of trust, confidence, and
loyalty to the corporation. Since the obligations to act in the best interest of the
corporation require directors to refrain from harming the corporation, their fiduciary
duties would not impose a duty on directors to disclose information on the financial
condition of the corporation to creditors.

This duty would, however, preclude directors from harming the corporation by
wrongfully prolonging its life through the incurrence of additional debt, or by
dissipating remaining corporate assets when the corporation is insolvent and has no
prospect of being able to meet its liabilities. An action for breach of fiduciary duty
arising from the incurrence of additional debt could conceivably be brought even
without a finding of dishonesty or fraud, since improper purpose could be broad
enough to encompass the wrongful prolongation of the corporations life. It would
therefore be feasible for a derivative action for breach of fiduciary duty to be brought
on behalf of the corporation against the directors for having depleted its remaining
assets while insolvent.124

In addition to this fiduciary duty, every director and every officer has a duty to
exercise the care, diligence and skill that a reasonably prudent person would exercise
in comparable circumstances pursuant to paragraph 122(1)(b) of the CBCA,
generally referred to as the duty of care. The standard for this duty is objective, so
the factual circumstances surrounding the directors actions are important.125 The
Supreme Court of Canada in Peoples noted that since the statute is open-ended,
creditors must be capable of being included amongst the beneficiaries of this duty.126
However, in order to succeed in showing a violation of this duty, the plaintiff must
show both a breach of the duty of care and a consequent harm to the plaintiff. A
breach will not be found if the directors acted prudently and on an informed basis.127
In Peoples, the unsuccessful but good-faith attempts to rescue a corporation on the
verge of insolvency did not constitute a violation of directors duties to the creditors.

In summary, acceptance of the proposition that wrongfully prolonging the
corporations life is harmful to the corporation means this occurrence can be used to
constitute a claim for breach of fiduciary duty. In addition, a claim for breach of duty

123 Peoples, ibid. at paras. 43, 46 [emphasis added].
124 See generally CBCA, supra note 3, s. 239; OBCA, supra note 79, s. 246 (stating that a derivative

claim can be brought against directors on behalf of the corporation).

125 Peoples, supra note 1 at para. 63.
126 Ibid. at para. 57.
127 Ibid. at paras. 66, 67; Axton Industries Ltd. v. Bobbiduncan Holdings Ltd. (2006), 151 A.C.W.S.
(3d) 839 at paras. 168-70 (B.C.S.C.). The breadth of the duty of care is confined by the business
judgment rule. For an explanation of the business judgment rule, see Part III.

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

of care might also be possible if it can be proven that directors were not acting on a
reasonably informed basis.

193

B. Claim for Negligent or Fraudulent Misrepresentation: Similar but

not Identical

to

to whom

the creditor

It is a well-known common law principle that when a party induces another to

enter into a contract by making careless statements, or statements which the former
knows to be false, the innocent party may have a claim for negligent or fraudulent
misrepresentation. While claims for misrepresentation could encompass claims in
which creditors extend money or provide supplies to the debtor corporation based on
certain misrepresentations about the corporations financial status and its ability to
repay creditors, an essential distinction between misrepresentation and deepening
insolvency lies in the availability and potential consequences of each. An action for
misrepresentation would only be available
the
misrepresentation was made for the harm done to that particular creditor. If the action
is successful, funds would be restored to that creditor. While a claim for deepening
insolvency may arise under similar facts, it is brought by the corporation, or by all
creditors on behalf of the corporation, for harm done to the corporation. A successful
deepening insolvency action brings money back into the corporation, which then
benefits all creditors on disbursement. Therefore, while a claim for misrepresentation
cannot act as a replacement for the deepening insolvency doctrine, an individual
creditor might pursue it in conjunction with a claim for breach of fiduciary duty or the
oppression remedy.
An independent cause of action must be established against corporate officers in
order to find them personally liable for misrepresentation.128 As a general rule,
directors and officers are exposed to personal liability for acts committed in the
course of their employment,129 with the exception in Said v. Butt, which held that
directors and officers are not liable for inducing a breach of contract between the
corporation and a third party.130 While the principles appear uncomplicated at first
glance, a deeper look reveals that courts have been inconsistent in the development of
the law on directors personal liabilities in tort. In general, it is possible to sue a

128 It is important to note that establishing an independent cause of action against a director is
different than piercing the corporate veil. See ADGA Systems International Ltd. v. Valcom Ltd.
(1999), 43 O.R. (3d) 101 at 105, 168 D.L.R. (4th) 351 (C.A.) [ADGA Systems cited to O.R.]; Said v.
Butt, [1920] 3 K.B. 497 (C.A.).

129 David Debenham, Executive Liability and the Law (Toronto: Thomson Carswell, 2006) at 44.
130 Said v. Butt, supra note 128. For an explanation of Said v. Butt, see Nicholls, supra note 36 at 8-
9; Janis Sarra, The Corporate Veil Lifted: Director and Officer Liability to Third Parties (2001) 35
Can. Bus. L.J. 55 at 59 [Sarra, Director and Officer Liability]. Sarra maintains that the exception of
the tort of inducing breach of contract exists because (1) it ensures others who deal with the
corporation will not have available to them actions for both breach of contract and personal tort claims
against the directors, and (2) it ensures minimal interference with directors decisions to terminate the
corporations contracts (ibid.). See also ADGA Systems, supra note 128 at 105-06.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

194

director personally if the act complained of is not attributable to the corporation but
rather is an action separately belonging to the individual director.131 From that rule,
two lines of cases have emerged. One line, beginning with ScotiaMcLeod Inc. v.
Peoples Jewellers Ltd.132 maintains that, absent fraud or deceit, directors acting within
their duties will rarely be held personally liable in tort to third parties for actions they
commit through their corporations.133 As Janis Sarra has pointed out, directors would
therefore be able to avoid personal liability if their tortious conduct was committed in
the best interests of the corporation.134
The other, more recent line of cases has interpreted ScotiaMcLeod more broadly,

and articulated a more expansive realm within which tortious conduct can be the
subject of liability. In ADGA Systems International Ltd. v. Valcom Ltd., the Court of
Appeal for Ontario determined that corporate officers should be held liable for torts
they commit, even if the commission was in good faith and in the best interests of the
corporation,135 with the exception of the situation covered by Said v. Butt.136 The court
has gone on to uphold this slightly broader approach in subsequent decisions,137
leading to the conclusion that directors and officers may be found personally liable
for torts they commit, even when acting in the course of duty and in the best interests
of the corporation. Note that any fraudulent action taken by a director to increase
corporate profits is not considered to be in the bona fide interests of the
corporation.138

Canadian jurisprudence has therefore developed a body of law capable of dealing
with the tortious conduct of directors. Involvement in fraudulent misrepresentation
will leave these individuals open to personal liability for their tortious acts, and any
tortious act that does not meet the threshold for fraud may leave them open to liability
under the principles articulated in ADGA Systems. Provided a duty of care to the
plaintiff can be found, a necessary element in the maintenance of a tort action in
common law provinces, there is no bar to bringing a tort claim against corporate

131 Joel A. Pinsky & Peggy R. Bybelezer, Canada in Anker Srensen, ed., Directors Liabilities in

Case of Insolvency (London: Kluwer Law International, 1999) 377 at 401 [Pinsky & Bybelezer].

132 (1995), 26 O.R. (3d) 481 at 490-91, 129 D.L.R. (4th) 711 (C.A.) [ScotiaMcLeod].
133 See also Alper Development, Inc. v. Harrowston Corp. (1998), 38 O.R. (3d) 785 (C.A.) [Alper
Development]; Rafiki Properties Ltd. v. Integrated Housing Development Ltd. (1999), 45 B.L.R. (2d)
316, 85 A.C.W.S. (3d) 1034 (B.C.S.C.).

134 Director and Officer Liability, supra note 130 at 64, 66. This doctrine was subsequently
confirmed in Normart Management Ltd. v. West Hill Redevelopment Co. ((1998), 37 O.R. (3d) 97, 155
D.L.R. (4th) 627 (C.A.)) and in Alper Development (ibid.).

135 Supra note 128 at 111-14.
136 Ibid. at 107.
137 NBD Bank, Canada v. Dofasco Inc. (1999), 46 O.R. (3d) 514, 181 D.L.R. (4th) 37 (C.A.) [NBD
Bank cited to O.R.]; Immocreek Corp. v. Pretiosa Enterprises Ltd. (2000), 186 D.L.R. (4th) 36, 131
O.A.C. 358 (C.A.); Lana International Ltd. v. Menasco Aerospace Ltd. (2000), 50 O.R. (3d) 97 at
paras. 43-44, 190 D.L.R. (4th) 340 (C.A.).

138 Kepic v. Tecumseh Road Builders (1987), 23 O.A.C. 72, 18 C.C.E.L. 218 (C.A.); ADGA Systems,

supra note 128 at 110.

195

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

officers. While Canadian courts have not yet found a common law duty of disclosure
resting on directors, it is possible for a duty of care to arise if the situation lends itself
to a factual finding of negligent misrepresentation.

To hold a director personally liable for misrepresentation, a duty must be found
between the creditor and the director. In NBD Bank, a case containing a detailed
analysis of the development of the duty of care, a corporate officer was found
personally liable for misrepresenting corporate information to a creditor at a time the
corporation was nearly insolvent in order to secure a loan from the plaintiff bank.139
Two weeks after the loan extension, the corporation announced its insolvency. In a
claim brought by the bank against the officer, the court found the officer personally
liable for having misrepresented the financial information. Justice Rosenberg found
that a duty of care existed between the director and the corporation by relying on
Hercules Management Ltd. v. Ernst & Young,140 which, in turn, relied on Justice
Wilsons summary of the Anns test141 in Kamloops (City of) v. Nielsen:142

(1) is there a sufficiently close relationship between the parties (the [defendant]
and the person who has suffered the damage) so that, in the reasonable
contemplation of the [defendant], carelessness on its part might cause damage
to that person? If so,
(2) are there any considerations which ought to negative or limit (a) the scope
of the duty and (b) the class of persons to whom it is owed or (c) the damages
to which a breach of it may give rise?143

Therefore, in order for a duty of care to exist between the parties, a proximate
relationship must first be establisheda relationship that arises through reliance by
the plaintiff on the defendants words.144 Such a relationship is easily found between
a corporate officer who makes decisions on behalf of the corporation and who relays
information to a creditor, and the creditor who subsequently relies on this information
to extend a loan to the corporation. In NBD Bank, the court found that the corporate
officer ought reasonably to have foreseen that the respondent would rely upon his
representations, and accordingly, that such reliance was reasonable.145
With regard to the second part of the Anns test, which contemplates whether
policy considerations should preclude the court from finding a duty in the
circumstances, Justice Rosenberg refrained from finding a blanket duty and instead
noted that the circumstances of each case will determine whether a duty arises.146 In
addition, he failed to see how the imposition of liability on directors for negligent

139 Supra note 137.
140 [1997] 2 S.C.R. 165, 146 D.L.R. (4th) 577 [Hercules cited to S.C.R.].
141 See Anns v. Merton London Borough Council, [1978] A.C. 728, [1977] 2 All E.R. 492 (H.L.).
142 [1984] 2 S.C.R. 2, 10 D.L.R. (4th) 641.
143 Ibid. at 10-11; NBD Bank, supra 137 at para. 45.
144 Hercules, supra note 140 at para. 24.
145 NBD Bank, supra note 137 at para. 48.
146 Ibid. at para. 58.

[Vol. 53

MCGILL LAW JOURNAL / REVUE DE DROIT DE MCGILL

196

misstatements made prior to the companys insolvency would be problematic, and
found that it would be contrary to good policy to immunize officers from the
consequences of their negligent statements which might otherwise be made in
anticipation of being forgiven under a subsequent corporate proposal or
arrangement.147 Finally, with regard to the potential for indeterminate liability, a
fundamental policy consideration,148 Justice Rosenberg quoted Justice La Forest,
who, writing for the court in Hercules, had noted that the extent of liability is
sufficiently constrained by the requirements that the defendant make the statement to
the plaintiff and that the statement be used for the purpose for which it was
intended.149
While NBD Bank dealt with negligent misrepresentation, the higher threshold of
fraudulent misrepresentation would be met by proving that the corporate officer,
knowing the information he was conveying to be untrue, acted with an intention to
deceive the party relying on the misrepresentation. In fact, several cases have reached
similar findings, as courts have been leaning in that direction for years. In Hall-Chem
Inc. v. Vulcan Packaging Inc.,150 it was suggested that directors who engage in
fraudulent behaviour take on an identity separate from the corporations and should
be held personally liable for the harm inflicted.151 The director in Re Traders Trust
and Kory was found liable for fraudulent misrepresentation when the money he had
acquired to fund a mortgage investment was subsequently used to pay the companys
debts.152 In TCT Logistics, the court intimated that a creditor who is misled by the
corporation with regard to the latters financial situation would be able to hold a
director personally liable if the director was aware of the misrepresentation.153
A claim for negligent or fraudulent misrepresentation cannot act as a replacement
for the deepening insolvency doctrine, but it could be pursued in conjunction with a
claim for breach of fiduciary duty, or a claim under the oppression remedy. While
there is no common law duty of disclosure for directors, the courts have determined
that in certain circumstances, a duty of care can arise between directors who
misrepresent the financial condition of the corporation and the parties who rely on the
misstatement.

147 Ibid. at para. 54.
148 Hercules, supra note 140 at para. 31.
149 Supra note 145 at para. 59.
150 (1994), 12 B.L.R. (2d) 274, 46 A.C.W.S. (3d) 1053 (Ont. Gen. Div.).
151 Pinsky & Bybelezer, supra note 131 at 402.
152 [1916] 26 D.L.R. 41, 9 W.W.R. 538 (B.C.S.C.); M. Magnan, Directors Liability in Canada

(Blaine, Wash.: STP Specialty Technical Publishers, 2002) at 1-34b.

153 See Abbott, supra note 16 at 9; TCT Logistics, supra note 81 at paras. 10-11. See also Toronto-
Dominion Bank v. Leigh Instruments Ltd. (Trustee of) (1991), 4 B.L.R. (2d) 220, 51 O.A.C. 321 (Ont.
Div. Ct.).

197

J. GIRGIS DEEPENING INSOLVENCY IN CANADA?

2008]

Conclusion
While much about deepening insolvency has yet to be settled in the United
States, questions about the doctrines applicability and functionality in Canada are
presently at the forefront of Canadian commercial law. The principle of holding
directors and third parties liable for wrongfully prolonging a corporations life is
appealing on an intuitive level and seems to come with many advantages. Indeed, the
benefit to creditors of the deepening insolvency doctrine is indisputable: the
successful pursuit of directors and third parties in a deepening insolvency action
allows for money to brought into the corporate debtors estate to repay creditors.
However, before the legal profession gets carried away with the idea of importing this
U.S. doctrine into Canada, it is important to look to the remedies in Canadian law that
may already address those harms. As this analysis has indicated, the statutory
oppression remedy is capable of addressing the harm sought to be addressed by the
deepening insolvency doctrine. While the interpretation proposed above may require
courts to expand their understanding and application of the oppression remedy, doing
so would allow Canadians to develop an existing remedy rather than import an ill-
defined doctrine from the United States. Therefore, before Canadians become as
enamoured with deepening insolvency as U.S. courts have been in recent years,
examining the current state of Canadian law will necessarily lead to the conclusion
that importing the deepening insolvency doctrine into Canada is not necessary.